The Update contains a round-up of key developments in this area during July 2016.
Market Abuse Regulation (MAR)
- European Commission and the European Securities and Markets Authority confirm MAR closed period will run prior to, and end with, announcement of prelims in most cases
- City of London Law Society and Law Society Company Law Committees' Joint Working Parties publish Q&As setting out a suggested approach to implementing certain aspects of MAR
- Executive Remuneration Working Group publishes its final recommendations on executive pay in UK listed companies
- Quoted Company Alliance revises its Remuneration Committee Guide for Small and Mid-Size Quoted Companies
- European Commission reports back on the efficiency, implementation and enforcement of the remuneration rules in CRD IV
Market Abuse Regulation
European Securities and Markets Authority (ESMA) confirms MAR closed period will run prior to, and end with, announcement of prelims in most cases
In the May edition of our Employee Incentives Update we reported on the Financial Conduct Authority's (FCA) supervisory approach to the interpretation of closed periods in Article 19(11) of MAR in light of a preliminary announcement made pursuant to Listing Rule 9.7.A.1R.
At that time, the FCA announced that, pending clarification from the European Commission and ESMA, it would continue to take the view that where an issuer announced preliminary results and the results announcement contained all inside information expected to be included in the subsequent year-end report, the closed period would exist immediately before the preliminary results were announced.
ESMA has now published an updated version of its Q&As on MAR which now clarifies this issue, agreeing with the FCA's view and noting that, in the event that the information set out in the preliminary announcement changes after its publication, this will not trigger another closed period but should be addressed in accordance with Article 17 of MAR (the rules relating to the public disclosure of inside information).
ESMA's Q&As emphasise that in any case, PDMRs will be subject at all times to the core prohibitions in MAR as regards insider dealing, unlawful disclosure and market manipulation.
Given that ESMA's clarification of this issue is aligned with the FCA's view, the FCA has now updated its supervisory approach to refer to ESMA's Q&As.
City of London Law Society (CLLS) and Law Society Company Law Committees' Joint Working Parties publish Q&As setting out a suggested approach to implementing certain aspects of MAR
The CLLS and Law Society Company Law Committees' Joint Working Parties have, in the light of uncertainties in the interpretation of MAR and related subsidiary regulations, drafted a set of 32 Q&As setting out a suggested approach to implementing certain aspects of MAR.
The Q&As deal with practical situations and suggest an appropriate response, setting out a reasoned rationale for the answer given. Most of the Q&As are in respect of PDMR dealings but they also cover share buy-backs, disclosure of inside information, insider lists and investment recommendations.
The Joint Working Parties have stated that the Q&As are subject to review and amendment in the light of future development on the implementation of MAR in practice and to any relevant future UK or EU guidance published in relation to MAR.
Executive Remuneration Working Group (ERWG) publishes its recommendations on executive pay in UK listed companies
The ERWG is an independent panel of experts set up last year to review pay structures at UK listed companies in order to address the concern that executive remuneration has become too complex and is not fulfilling its purpose. The ERWG has now published its final report (Final Report) setting out ten recommendations that it considers are necessary to rebuild trust in executive pay structures in the UK.
The ERWG considers that the Final Report represents "a far-reaching plan to simplify pay structures for company bosses while improving the alignment of their interests with those of the shareholders who own their businesses".
The recommendations address five key areas:
- Increasing flexibility
- Companies to be given the flexibility to select the structure that is most appropriate for the company's strategy and business need, rather than focusing solely on the currently dominant 'one-size-fits-all' Long-Term Incentive Plan (LTIP) pay structure. The Final Report includes possible alternative structures to illustrate what this flexibility might mean in practice, although stressing that these alternative approaches should not be seen as an exhaustive or an approved list but instead as examples to explore "the practical reality of a more flexible system".
- This is the key recommendation if there is to be a significant change in remuneration structures. It will be interesting to see the responses of the Investment Association's members as well as other institutional investor groups, such as ISS and Glass Lewis, to these proposals.
- Strengthening remuneration committees and their accountability
- Non-Executive Directors should serve on the remuneration committee for at least a year before taking over the chairmanship of the committee. The ERWG asked the Financial Reporting Council (FRC) to consider reflecting this in the UK Corporate Governance Code and the FRC has responded positively stating that it will "consider the recommendation on the need for RemCo chairs to have the skills and experience to undertake the role as part of a wider review of measures we can take to address public concern".
- Boards should ensure the company chairman and whole board are appropriately engaged in the remuneration setting process. This will ensure that the decisions of the remuneration committee are agreed by the board as a whole.
- Remuneration committees need to exercise independent judgement and not be over reliant on their remuneration consultants particularly during engagements with shareholders. Remuneration committees should regularly put their remuneration advice out to tender.
- Improving shareholder engagement
- Shareholder engagement should focus on the strategic rationale for remuneration structures and involve both investment and governance perspectives. Shareholders should be clear with companies on their views on and level of support for the proposals.
- Companies should focus their engagement on the material issues for consultation. The consultation process should be aimed at understanding investors' views. Undertaking a process of consultation should not lead to the expectation of investor support.
- Increasing transparency on target setting and use of discretion
- Remuneration committees should disclose the process for setting bonus targets and retrospectively disclose the performance range.
- The use of discretion should be clearly disclosed to investors with the remuneration committee articulating the impact the discretion has had on remuneration outcomes. Shareholders will expect committees to take a balanced view on the use of discretion.
- Addressing the level of executive pay
- The board should explain why the chosen maximum remuneration level as required under the remuneration policy is appropriate for the company using both external and internal (such as a ratio between the pay of the CEO and median employee) relativities.
- Remuneration committees and consultants should guard against the potential inflationary impact of market data on their remuneration decisions.
The Investment Association has indicated that it intends to review its Principles of Remuneration in light of the ERWG's recommendations and, given that Helena Morrissey, Chair of the Investment Association, was one of the five members of the ERWG, it seems highly likely that the Principles of Remuneration will be revised to reflect the recommendations of the ERWG.
Binding vote on executive remuneration?
The Final Report also acknowledges the recent comments on binding pay votes made by the new Prime Minister, Theresa May. You will recall that imposing a binding vote on the remuneration report or remuneration actually received was considered by Vince Cable in 2012/13 when he was Business Secretary but was rejected due to concerns over legal and operational issues. In particular, there were questions as to how such a vote would relate to an individual director’s contract and the impact such uncertainty would have on the ability of UK listed companies to attract talent.
The Final Report, whilst commenting that the ERWG has not had sufficient time to consider all the options and the impact such a policy change would have on market practice and the ability of UK companies to attract talent, recognises that the trust and confidence of investors and the wider society needs to be rebuilt and that additional binding votes might be a means of aiding this process. A suggested approach for consideration put forward by the ERWG is that a binding vote could be imposed on companies that have failed to receive support from 75% of shareholders on their previous year's remuneration report.
The Quoted Company Alliance (QCA) revises its Remuneration Committee Guide for Small and Mid-Size Quoted Companies (Remuneration Committee Guide)
The QCA has updated its Remuneration Committee Guide. The Remuneration Committee Guide covers key aspects such as the operational aspects of the committee; the roles and responsibilities of those on the committee and those that work with the committee; factors to consider in setting remuneration policy; communicating with shareholders; and the remuneration report.
It has been revised and updated to address new remuneration regulations and developments in governance behavior and best practice since it was last updated in 2012.
Key changes include:
- A new section providing a high-level explanation of the changes to the legal regime for main market companies that took place in 2013.
- Specific reference made to clawback arrangements.
- Expanding the narrative on the roles and responsibilities of the people involved in the work of the remuneration committee, placing greater emphasis on the role of the remuneration committee chairman.
- Integrating aspects of the Quoted Companies Alliance Corporate Governance Code for Small and Mid-Size Quoted Companies (QCA Code), published in 2013 and of the Audit Committee Guide for Small and Mid-Size Quoted Companies, published in 2014.
- Expanding the section on communicating with shareholders and creating a new section on the remuneration report, to reflect the increased focus on relations with shareholders.
A copy of the Remuneration Committee Guide can be purchased from the QCA website.
The European Commission reports back on the efficiency, implementation and enforcement of the remuneration rules in CRD IV
The European Commission is required to report to the European Parliament and the Council of the EU on the efficiency, implementation and enforcement of the CRD IV remuneration rules (which include rules on the governance of remuneration processes, performance assessment, disclosure and pay-out of variable remuneration of identified staff). To this end, it launched a consultation back in October 2015 on (i) the impact of the bonus cap in particular on financial stability, competitiveness and staff in non-EEA countries; and (ii) the efficiency of the CRD IV remuneration rules (in particular, whether the rules have reduced risk-taking; whether they have had any unintended, negative consequences; and how performance is assessed).
The European Commission's report, based (in part) on the outcome of the consultation, was published during July. It gives a largely positive assessment of the CRD IV remuneration rules. Key findings from the report include:
- The Directive has had a significant effect on risk management. Deferral of variable pay, malus arrangements and a maximum ratio for the variable pay of risk-taking personnel are seen to be effective incentives even at this early stage.
- Competitive disadvantages with regard to attracting and retaining staff from unregulated sectors could not be verified.
- Problems have been found with regard to clawback clauses in the context of national employment law.
- Other problems concern the need for rules that are better adapted to the business scale. The rules work well in the case of big and significant institutions. For small and non-complex institutions, which are less engaged in risky activities and which pay out low amounts of variable remuneration, the relatively high implementation cost of deferral and pay-out in instrument are of concern.
- Member States have made wide use of exclusions. Regulating the extent, process and identification of such exclusions at the EU-level would further harmonise remuneration policies in the member states.
- At the current time there is insufficient evidence to draw final conclusions on the impact of the maximum ratio between variable and fixed remuneration on competitiveness, financial stability and staff working for non-EEA subsidiaries. Conclusive findings are likely only to be reached once more implementation experience is gained.
The European Commission will now conduct an impact assessment examining options for addressing the issues identified above. This work will be part of the broader revision of CRD IV and the CRR that is currently under consideration by the Commission and planned for the end of 2016.